Case / Fair - Chapter 35 -2-4

Chapter 35 -2-4

This is a guidance answer ... your actual answer during the exam should be longer than this answer ...

2.     (a)    Answers can include, an increase in British interest rates, a decrease in U.S. interest rates, a decrease in the British price level, and an increase in the U.S. price level.

        (b)    All of the above would also cause the supply curve to shift left.

        (c)    The two changes in interest rates listed in (a) above (which would raise the value of the pound without any other simultaneous change in import or export demand) would make British goods relatively more expensive and decrease Britain’s trade balances (shrink the surplus or increase the deficit).

4.     (a)    The consumption function does not change so instead of spending their money on Japanese goods, U.S. citizens will spend it on domestic goods. All else equal, this will stimulate U.S. output and decrease U.S. unemployment, and decrease output and employment in Japan.

        (b)    If income rises, consumers are likely to buy more imports as well as more domestic goods. Imports from Japan will increase somewhat after the initial decrease.

        (c)    If imports decrease, then the demand for yen will also decrease because importers will not need as many yen to purchase Japanese goods.

        (d)    The yen will depreciate and the dollar will appreciate. This gives U.S. consumers more buying power in the market for foreign goods. Consumers will buy more imports, causing a decrease in aggregate expenditure on domestic output. Output and employment in the United States will fall. The current account deficit will rise, but the total balance of payments will still sum to zero.

        (e)    The quota would have to increase U.S. output and employment, at least in the short run. The increase in the U.S. trade balance increases U.S. output and employment. This causes the dollar to appreciate, which works to decrease output.

Courtesy of Case/Fair/Oster, 11th edition, 2014

Case / Fair - Chapter 34 -3-6-7-12-13

Chapter 34 -3-6-7-12-13

This is a guidance answer ... your actual answer during the exam should be longer than this answer ...

3.     Clearly, apparel is produced with cheap labor, and we buy most of our apparel from abroad because of the relatively high cost of labor in the United States. On the other hand, aircraft are produced with highly skilled workers, and the United States does enjoy a comparative advantage there. The United States does not have as large an endowment of oil reserves as the rest of the world, yet we are a big consumer. Both vehicles and food products are very heterogeneous. Vehicles lend themselves to “acquired comparative advantage.” While the United States has a lot of very fertile land for crop production, many things that we consume are not suited for production: coffee, tea, dates, tropical fruits (like bananas), and so forth. The table demonstrates the enormous complexity of the pattern of international trade.

6.     (a)    The opportunity cost of a bottle of red wine is 1.5 bottles of white in the United States and 2 bottles of white in Australia. The United States, therefore, has a comparative advantage in red wine. The opportunity cost of a bottle of white wine is .66 bottles of red in the United States and .5 bottle of red in Australia. Australia, therefore, has a comparative advantage in white wine.

        (b)    No, at the current exchange rate, both white and red wine are cheaper in Australia. U.S. citizens will want to import both types of wine from Australia, but Australians will not want to import U.S. wine.

        (c)    In this situation, we would expect the price of the dollar to decrease until U.S. red wine became attractive to Australians whereas Australian white wine remained attractive to Americans. [An exchange rate between 1.5 (calculated as 15 US$/10 AU$) and 2 (calculated as 10 US$/5 AU$) U.S. dollars to 1 Australian dollar would accomplish this.]

        (d)    In the long run, we would expect exchange rates to adjust until Americans were exporting red wine to Australia and Australians were exporting white wine to the United States.

7.     Often times, countries differentiate their products to please a wide variety of tastes that exist worldwide. Just as some Americans may have a preference for foreign-made shirts, some foreigners may have a preference for shirts produced in America. The United States, which may not have a natural comparative advantage in producing shirts, could have an acquired comparative advantage in the production of specific kinds or styles of shirts. These differing global tastes would explain why a country may import and export the same type of product.

12.    These nations can still benefit by trading with each other. Even with an absolute advantage in everything it produces, Pixley can not have a comparative advantage in everything, and the basis of trade is made on comparative advantage. Pixley will benefit if it chooses to only produce those goods which can be produced at a lower cost relative to other goods. The same is true for Hooterville. Even though Hooterville has an absolute disadvantage in everything it produces, it will have a comparative advantage in at least one good.

13.    While lower exchange rates do make a nation’s exports more attractive, they also make a nation’s imports more expensive. Consumers will end up paying a higher price for all imports, reducing their buying power. With higher prices on imports, consumers will purchase fewer, even when there is a comparative advantage in production. Also, the exchange rate could drop so low that the currency becomes virtually worthless. If this happened, other countries would be very hesitant to accept this nation’s currency for payment of any goods or services.

Courtesy of Case/Fair/Oster, 11th edition, 2014

Case / Fair - Chapter 25 -9-10-11-13-17

Chapter 25 -9-10-11-13-17

This is a guidance answer ... your actual answer during the exam should be longer than this answer ...

9.     M2 includes everything in M1, plus savings accounts, money market accounts, and some other categories. A shift of funds between, for example, savings accounts and checking accounts, will affect M1 but not M2, because both savings accounts and checking accounts are part of M2.

10.    (a)    Agree. The two sentences are correct. When the Fed sells bonds, the proceeds do not go back into circulation. Rather, the proceeds are withdrawn from the economy, reducing the quantity of reserves in the system and reducing the supply of money. Fed open market operations change the money supply.

        (b)    Disagree. The money multiplier is equal to 1/RR. The expenditure (fiscal) multiplier is equal to 1/MPS. The expenditure multiplier and the money multiplier are very different. The expenditure multiplier gives the change in equilibrium output (income) that would result from a sustained change in some component of aggregate expenditure.

11.    Money injected through open market operations results in a multiple expansion of the money supply only if it leads to loans, and loans can be made only if the new money ends up in banks as reserves. If the Fed buys a bond from James Q. Public, who immediately deposits the proceeds into a dollar-denominated Swiss bank account, the U.S. money supply won’t expand at all. If the money ends up in his pockets or in his mattress, the expansion of the money supply will stop right there. If he had deposited the proceeds in a U.S. bank, excess reserves would have been created, stimulating lending and further money creation.

13. People in Zimbabwe will accept U.S. dollars so long as they believe that others in the country will also accept U.S. dollars. The currency does not have to be issued by the ruling government to act as a medium of exchange in that country. Zimbabwean dollars had become virtually worthless, and U.S. dollars were a good store of value, so people had faith in the value of the U.S. dollar.

17.    The three tools the Fed can use to change the money supply are changing the required reserve ratio, changing the discount rate, and engaging in open market operations.

        If the Fed increases the required reserve ratio, banks would be legally required to hold more of all deposits as required reserves. The more banks have to legally keep as reserves, the less they have to loan to customers. As banks loan less, the money supply decreases. If the Fed lowers the required reserve ratio, banks would have more money to loan. The more banks loan, the larger the money supply grows.

        If the Fed increases the discount rate, it charges banks more to borrow from the Fed. If the discount rate increases, banks will tend to borrow less, and this leaves banks less to loan, therefore decreasing the money supply. If the Fed decreases the discount rate, banks will pay less to borrow from the Fed. This will make it more attractive for banks to borrow, and the more they borrow, the more they can loan, which will increase the money supply.

        If the Fed makes an open market purchase of government securities, it pays for the security by writing a check that, when it clears, expands the quantity of reserves in the system which increases the money supply. If the Fed makes an open market sale of government securities, it receives a check which, when cleared, reduces the quantity of reserves in the system which decreases the money supply.

Courtesy of Case/Fair/Oster, 11th edition, 2014

Case / Fair - Chapter 20 - 1-2-8-9-12-13

Chapter 20 - 1-2-8-9-12-13

This is a guidance answer ... your actual answer during the exam should be longer than this answer ...

1.     Inflation is an increase in the overall price level. In the simple economy described in the question, you might be tempted to look at the average price of the three goods to see how the overall price level has changed. On January 1, 2012 the average price was ($2.50 + $3.00 + 1.50)/3 = $2.33, whereas at the end of the year it was ($5.00 + $2.00 + 1.50)/3 = $2.83. From this you can conclude that on average prices are higher. This is a simple version of a price index. A better measure would include information about the relative importance of each of the three goods in consumer’s budgets (you could then construct a weighted average as your price index, which is discussed in chapter 7).

2.     The unemployed are those who are not working for pay or profit but who have made specific efforts to find a job during the week of the employment survey. In simple terms, it is the excess of labor supplied over labor demanded in the market. The labor demand curve measures the quantity of labor (workers or hours) demanded by firms at each possible wage rate. Firms’ demand for labor is derived from the demand for products. Firms will hire workers as long as the product of their labor sells for a price high enough to produce a profit. Thus, the “productivity” of workers is critical. Labor supply reflects the choices made by households to work and how much to work. The alternative to working is leisure or “home production.” Home production can include child rearing, subsistence farming, or other unpaid work. The value of leisure and home production is the opportunity cost of working.

8.     Wars result in high levels of government spending, which helps to increase total spending in the economy.

9.     Wrong. Incomes have actually risen faster than prices, so that the purchasing power of the average citizen has increased. Prices may now be higher in dollar amounts, but compared to people’s earnings, some goods may in fact be cheaper than they were in the 1940s.

12.    The classical belief is that markets are resilient and that wages and prices are flexible. Thus the decline in the demand for auto workers should result in lower wages. This will cause some workers to cease looking for work and will serve as an incentive for firms to increase the number of workers demanded. What would otherwise be a surplus (unemployment) in the labor market results in the market clearing, or no additional unemployment. Keynes argued that wages may not adjust right away. Thus the decline in the demand for labor is not met by a commensurate drop in the wage rate. This means that there will be many more auto workers actively seeking employment but much fewer being hired in the market, so unemployment will increase.

13.    Prior to the Great Depression, economists applied microeconomic, or classical, models to economy-wide problems. Classical models could not explain the Great Depression. According to classical models, the economy is self-correcting and unemployment should not persist. During the Great Depression, very high levels of unemployment persisted for about 10 years. Because classical models could not explain the Great Depression, the approach to macroeconomics had to be rethought.

Courtesy of Case/Fair/Oster, 11th edition, 2014

Case / Fair - Chapter 15 - 1-2-3-11

Chapter 15 - 1-2-3-11

This is a guidance answer ... your actual answer during the exam should be longer than this answer ...

1.     (a)    Disagree. There are no barriers to entry in monopolistic competition, and economic profits are eliminated in the long run.

        (b)    Disagree. Price does not equal marginal cost in the short or long run in monopolistically competitive industries.

2.     Bands are an example of monopolistic competition. Firms are small and have some but not much market power. Better bands are more expensive than lesser-known bands. The average local band is not likely to be earning economic profit. Clearly, there is product differentiation as each group tries to attract fans and CD buyers. Bands advertise and try to improve. Booking agents often serve as barriers to the entry of new bands. In a way, bands try to achieve market power and price-setting ability by differentiating their product. A good band has fewer substitutes than lesser-known bands.

3.     The key is the availability of substitutes. A monopoly is a firm producing a product for which there is no close substitute. When they were just another band, clubs could hire a cheap band and consumers didn’t know the difference or care. With their success, there became fewer substitutes in the minds of consumers.

11.    For a purely competitive firm, price is equal to marginal revenue because the firm can sell as much output as it chooses at the standardized market price. Because of this, total revenue will always increase by the amount of the price for each additional unit sold, so marginal revenue is equal to the price. For a monopolistically competitive firm to sell additional output, it must lower the price for each additional unit it wants to sell. Therefore, total revenue increases as more units are sold, but by less than the price since the decrease in price applies not only to the additional output but also to all previous output.

Courtesy of Case/Fair/Oster, 11th edition, 2014

Case / Fair - Chapter 14 - 1-3-9-12

Chapter 14 - 1-3-9-12

This is a guidance answer ... your actual answer during the exam should be longer than this answer ...

1.     (a)    and (d) are probably oligopolies dominated by a few firms: (b), (c), and (e) are clearly monopolistically competitive because there is lots of product differentiation, many firms, and lots of entry and exit.

3.     Shipbuilding and wine production: not contestable. Both require large investments of land and capital that cannot easily be moved to another location or another industry. Trucking is contestable because it’s easy to move trucks to new locations. Housecleaning services are contestable because they require a very small initial investment.

9.     (a)    Disagree. In contestable markets, oligopolies will be charging competitive prices. Even when oligopolies charge prices above competitive levels, they will sometimes deliver a more innovative stream of products and/or allow scale economies to be realized.

        (b)    Disagree. The existence of a fringe of small firms is relatively common in oligopolies and does not vitiate the market power of the larger firms.

12.    You should agree with this statement. Collusion occurs when price- and quantity-fixing agreements among producers are explicit. If all firms in the industry explicitly agree on fixing the price and quantity in the industry, they will produce where the industry marginal revenue is equal to the marginal cost. In essence, they will be acting as one monopolistic firm.

Courtesy of Case/Fair/Oster, 11th edition, 2014

Case / Fair - Chapter 13 - 1-2-9-12-14-15

Chapter 13 - 1-2-9-12-14-15

This is a guidance answer ... your actual answer during the exam should be longer than this answer ...

1.     (a)    Disagree. A monopolist chooses quantity so that sets MC = MR, but then charges a price higher than MR. This is because a monopolist faces a downward-sloping demand curve. To sell more output, it must lower its price.

        (b)    Disagree. Demand still constrains monopoly. There are always substitutes (however distant) for a monopoly’s output. A rise in price causes a decrease in sales and may or may not decrease total revenue. But there is only one price that will maximize a monopoly’s profits.

        (c)    Agree. Demand elasticity is equal to –1  at the midpoint of the demand curve, and the marginal revenue curve bisects the quantity axis at that same level of output.

2.     A competitive firm can sell all the output it wants without having any impact on market price. For each additional unit sold, its revenue will rise by the market price. Hence, MR is the same at all levels of output.

        Each time a monopolist increases output by 1 unit, it must lower the price to sell it. The additional revenue the monopolist receives is less than the price because consumers who were already buying the output get a price break too. MR  is thus lower than price; and as output increases, both price and MR  decline.

9.     Answers will vary, but may include information such as the following in addressing the three questions:

        In what ways has Google acted to suppress competition? By purchasing DoubleClick, Google dominates the Internet advertising business. By purchasing YouTube, Google immediately took control of the web’s growing video market. Google’s increasing dominance in ad-serving gives it the power to make exclusive deals regarding internet searches and advertising with major Internet websites, and this will continue to expand its influence over its users.

        What private suits have been brought against Google? Two of the antitrust suits filed against Google include one filed by KinderStart, based on their unhappiness with their search engine placement, and one filed by Microsoft, requesting the government block Google’s acquisition of DoubleClick.

What are the benefits of a strong, profitable Google? A strong, profitable Google means continued reliability and convenience for its millions of users who enjoy its services. Growth at Google is good for its employees and shareholders and is also good for its users who want to enjoy more online innovations. Businesses that advertise with Google will also benefit because the stronger and more profitable Google is, the more exposure its advertising clients will receive.

12.    A monopoly is a single firm industry that has a product for which there are no close substitutes and that can block entry of new firms. The whole point of having a monopoly is that you can charge a price that is higher than the competitive price and prevent competition with barriers to entry. This makes it possible to earn economic profits over time. Generic rock bands face incredible competition. Whenever one seems to make it, 20 similar bands show up keeping the price of a gig down. But if you have a sound that lots of people like and a name that becomes recognized, you are acquiring market power in the form of a brand name that people may be willing to pay for. When demand becomes less elastic, it means that you can raise price without losing all of the demand for your product.

14.    A supply curve shows the relationship between the price of a product and the quantity of the product supplied. In perfect competition, the supply curve in the short run is the portion of the firm’s marginal cost curve that lies above the average variable cost curve. As the price of a good changes, the perfectly competitive firm moves up and down its marginal cost curve to determine the output quantity to produce. The output quantity produced by a monopoly depends on its marginal cost curve and on the marginal revenue associated with a specific price, which is based on the shape of its demand curve, so the amount of output is not independent of the shape of the demand curve as it is in pure competition. Therefore, a monopolist does not have a supply curve.

15.    This does not necessarily constitute a monopoly. Even though Gloria has the only McDonald’s in town, this does not mean that there are not any other competitors in town, such as Burger King, Wendy’s, or In-N-Out Burger. Also, consumers may be able to drive to a nearby town to patronize a different McDonald’s restaurant.

Courtesy of Case/Fair/Oster, 11th edition, 2014